Economic agenda on the top priority of the new government
10 July, 2014

Over 66 per cent of the voting population in the world's largest democracy cast its ballot in 2014, reflecting palpable electoral dissatisfaction with India's administrative and economic milieu. The exuberance at the expected change in government was so high that the Bombay Stock Exchange (BSE) surged 15 percent and the rupee gained four percent between March and May 16, 2014, when Narendra Modi was declared victorious in the national elections.

The
excitement notwithstanding, the fact of the matter is that the new
government inherits a beleaguered economy which is rife with poverty,
unemployment, unmanageable inflation, fading investment, decelerated
growth and lack of adequate infrastructure. Before we get into
reviewing what the Modi government can or will do to jump-start
India's economic growth, it is important to understand where the
fault lies.

A
couple of years back, normally referred to as the boom period, inept
macroeconomic policy paved the ground for the current economic mess.
The erroneous fiscal outlook and faulty monetary policy manufactured
India's largest-ever credit rush. This conspicuous failure of
India's economy is rooted in utopianism, which cannot be corrected
by a one-size-fit-all solution.

Grandiose
measures will have to be replaced by complex and involved management
of macroeconomic factors such that the current long view of the
economy is transformed into a more meaningful short view.
Macroeconomic policy in India lacks a deep institutional foundation,
resulting in the country bopping from one crisis to another. The
return of international markets to normalcy any time soon is a far
cry. India will have to deepen its liquid markets to absorb the shock
of a stagnating world economy.

For
this to happen, the country needs to replace its existing regulatory
framework with large-scale reforms in the financial sector because
without these reforms macroeconomic and financial uncertainty will
remain. Reformation of the regulatory framework is essential also to
prevent the misgivings raised by the knee-jerk economic interventions
that administrators in India tend to make when there is a financial
crisis, fiscal crisis and price instability. But these reforms can
only be meaningful and effective if there is sustained economic
growth; however, with less than five percent growth of the gross
domestic product (GDP), the new government faces the uphill task of
reviving India's crippled economy, which has grown at its slowest
pace in a decade.

Despite
the clear need for economic reforms, the government does not have the
fiscal space for far-reaching reforms as the
tax-to-GDP ratio has slipped to 10.2 per cent from a peak of 12.5 per
cent in 2007-08 and tax revenues are unlikely to recover immediately.
The new government plans to tackle supply side constraints, a major
cause for galloping inflation.

As
indicated in the book titled, "Getting India Back on Track"
(Bibek Debroy et al., London, 2014) fiscal consolidation, financial
sector reform, capital account convertibility, and countercyclical
monetary policy are the four components of the reforms that
macroeconomic stability and reduction of business cycle volatility
beckon. To forestall financial ailments like banking distress, world
economic meltdown, bankrupt pension systems, and securities scandals
that have plagued India in the recent past, a sound framework for
financial regulation is required. In India today, stressed loans
aggregate $100 billion, or 10 per cent of all loans.

A
recently released report of the RBI-appointed P.J. Nayak Committee
suggested that banks could raise equity if government stake in them
was reduced. The report also recommended that some weaker banks could
be merged with strong ones.

While
addressing a joint parliament session on June 9, 2014, H.E.Pranab
Mukherjee, the President of India, said, "We will work together to
usher our economy into a high growth path, rein in inflation,
reignite the investment cycle, accelerate job creation and restore
the confidence of the domestic as well as international community in
our economy."

The
to-do roster is long, but the vital actions that top the new
government's economic agenda are narrowing the fiscal deficit,
making the business climate congenial, introducing anti-inflation
measures, and perking up efforts to reduce the current account
deficit. All the measures that the government undertakes will have to
be linked with its revenues as it does not have enough leeway to make
grand plans which require substantial expenditure.

High
Inflation and the bottomless pit of India's fiscal and current
account deficit

India's
fiscal deficit may have narrowed over the last two years, but, as of
March 2014, it still lingers at 4.6 percent of GDP. When put in
context, this figure is alarmingly high, especially if we consider
China, which recorded a fiscal deficit of only 2.1 percent last year.
Moreover, there is a high chance that the fiscal deficit may actually
be higher than the quoted figure, given the probability of
statistical jugglery by previous state head honchos. India's fiscal
deficit touched 45.6 percent of the full-year target within two
months of 2014-15.

While
the deficit target slippage is a worry, the underlying source- below
par revenue (collection from taxes and duties) ? poses a huge
concern. The government would have to take cognizance of the fact
that stagnant revenues and messy expenditures will pose great
difficulties in meeting the 4.1 per cent-of-GDP fiscal deficit target
set in the Interim Budget.

Foreign
Direct Investment (FDI) is likely to be considered a major avenue for
raising capital. Additionally, in the upcoming budget the government
might consider introducing an aggressive disinvestment plan to reduce
the fiscal deficit. This would partly compensate the shortfall in the
country's revenue collections and rein in its deficit
proportionately. A larger effect of this will be visible in case
these funds are used for funding capital expenditures that would help
kick-start investment activity and growth.

However,
for a healthy investment cycle to be initiated, it is important for
the government to harmonize with the central bank's efforts to
restrain inflation. Controlled inflation, which can be achieved by
containing high levels of food inflation, is an essential precursor
to ensure buoyancy in investments.

During
his joint parliamentary address, Mukherjee added, "Containing food
inflation will be the topmost priority for my government. There would
be an emphasis on improving the supply side of various agro and
agro-based products by reforming the Public Distribution System. My
government will take effective steps to prevent hoarding and black
marketing."

Another
expected measure for reducing the fiscal deficit and eliminating, not
just alleviating poverty, is rationalisation of central subsidies.
Subsidies can be divided into productive and transfers. The latter
has averaged around three percent of GDP, almost double the levels of
the past decade. Such subsidies have become unviable as economic
growth has stagnated over the period.

Welfare
policies impact inflation and growth, thus it is imperative that
India's archaic policies are revised to reduce inflation and
accelerate economic growth. Since agriculture is the means of
livelihood for over 67 percent people in India, far-reaching changes
in that area are expected. The government is expected to increase
both public and private investment in agriculture. The government
could consider allowing private sector to build storage and stock-
gain, and shift from physical transfer of grains to consolidated cash
transfers.

Agri-infrastructure
will be one of the major avenues of investment in agriculture.
Farming can be made profitable through scientific practices and
agro-technology. One of Modi's biggest achievements in Gujarat was
the revival of agriculture, and he is likely to mirror that across
the nation. The agricultural value added in Gujarat grew at double
the rate of that in India, and was among the fastest rates recorded
anywhere in the world.

Thus,
at the national level a market stabilisation fund for farmers to get
the optimum price for their produce is very much in the offing. Modi
is likely to give attention to every state and see how agriculture
can be boosted there. For example, he is expected to recharge the
sugarcane industry in Uttar Pradesh by giving sugar mills incentives
to clear their arrears of over INR 7,500 crore.

Bad
subsidies do not augment the output, but good subsidies do. If the
non-merit subsidies on fuel and fertilisers are phased out over a
period of time and direct cash transfers are introduced, then the
genuinely poor and vulnerable households stand a chance of directly
receiving the much needed financial relief. Decontrol of oil is
expected to continue in the new regime, and oil subsidies, which
total INR 1 lakh crore, could be restructured. However, scrapping or
revising a subsidy is a politically contentious decision and might
take more time and effort than expected.

In
the past, the current account deficit (CAD) was reduced through
artificial means as all the expenditure in the fiscal deficit had not
been accounted for. The CAD was reined in by almost halving gold
imports, thus reviving gold smuggling. The new government is likely
to review gold import duties within three months of coming to power.
Another way to keep the CAD under control is to boost manufacturing
exports. Modi, who has turned around the manufacturing base in
Gujarat, is expected to appoint a commission to advance manufacturing
in the rest of the country.

To
re-ignite growth, the government would need to up the capital
expenditure, which has reduced from four per cent of GDP in 2003 to
1.7 per cent today. Despite it being a tough task, high volumes of
expenditure would be needed to start rebuilding infrastructure. In
order to step up its revenue collection, the government is expected
to rationalise and simplify its tax regime to make it conducive to
investment, enterprise and growth.

Tax
evasion is also an area which is likely to be addressed through tax
reforms. The July budget is likely to set a deadline for the
implementation of two key tax reforms ? the Goods and Sales Tax
(GST) and Direct Taxes Code (DTC) ? which till now did not get
consensus from all the states. It is estimated that with GST in
place, India's GDP will shoot up by a minimum of 1.5 to two
percentage points, and the DTC will positively impact compliance.

Growth
steered forward by a congenial business environment

It
is important to address the environment that characterizes investment
in India. Improving the business climate should be the anchor of the
new government's agenda. The reforms that the new government pushes
would pivot around making infrastructure available and giving
precedence to resource-based industries. The share of the
manufacturing sector in India's GDP is around 16 percent, which is
abysmally low when compared to other Asian countries.

The
foremost thing that has plagued the manufacturing sector is
government policy which leads to a difficult business environment,
rigidities in deployment of labour, insufficiency in infrastructure,
regulatory delays and absence of transparency, high cost and
unavailability of bank credit. While keeping land costs at acceptable
levels and reforming labour laws such that employers can hire and
fire are important policy level changes, the most critical is
addressing issues related to the business environment.

The
business environment stands to improve if India replaces the
multitude of forms with a combined application form for getting the
mandatory clearances. Currently, in India, businesses need to file
over 100 returns; doing business in India would become much easier if
a system of one common return was instituted. The business
environment would perk-up if the time taken to start and exit a
business is reduced significantly. Reducing the compliance burden
would help remove the clutter from India's business environment.
Uniformity across the country in terms of registrations would ease
the business environment in the country.

Narendra
Modi's government has introduced a deadline on every process of
regulatory clearance. This would help remove red-tape and bring about
more transparency. Cost of commercial credit could be reduced by
introducing more competition in the banking sector by issuing fresh
licenses on a regular basis. Modi has already mobilized efforts in
the direction of making the business climate congenial in India.

For
example, with respect to the mining industry, he is keen on a model
similar to Ultra Mega Power Projects, by which mining rights would be
awarded as a package, with all clearances in place. This is directed
towards reducing the time spent on obtaining permissions.

And
the verdict is?

It
has been nearly three decades since Indian voters delivered such a
momentous verdict. Whether Modi and his team will be able to stand up
to their promises and agenda of hope is yet to be seen. Among the
first indications will be the soon-to-be announced Union Budget of
2014 in which Modi might have to take some tough decisions to jack up
the process of India's economic recovery.

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About The Author

A Chartered Accountant by profession and Director on the board of Punjab National Bank (PNB), General Insurance Corporation of India (GIC) and Rural Electrification Corporation Limited (REC). Dr. Sunil Gupta is working flawlessly for the economic and social prosperity of India.